Brüder Mannesmann (FRA:BMM) Strong Profits May Be Masking Some Underlying Issues

The recent earnings posted by Brüder Mannesmann Aktiengesellschaft (FRA:BMM) were solid, but the stock didn't move as much as we expected. We believe that shareholders have noticed some concerning factors beyond the statutory profit numbers.

View our latest analysis for Brüder Mannesmann

Zooming In On Brüder Mannesmann's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to December 2021, Brüder Mannesmann had an accrual ratio of 0.55. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of €1.5m, in contrast to the aforementioned profit of €1.30m. We saw that FCF was €5.9m a year ago though, so Brüder Mannesmann has at least been able to generate positive FCF in the past. One positive for Brüder Mannesmann shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Brüder Mannesmann.

Our Take On Brüder Mannesmann's Profit Performance

As we have made quite clear, we're a bit worried that Brüder Mannesmann didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Brüder Mannesmann's underlying earnings power is lower than its statutory profit. On the bright side, the company showed enough improvement to book a profit this year, after losing money last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. So while earnings quality is important, it's equally important to consider the risks facing Brüder Mannesmann at this point in time. For example, Brüder Mannesmann has 4 warning signs (and 2 which shouldn't be ignored) we think you should know about.

Today we've zoomed in on a single data point to better understand the nature of Brüder Mannesmann's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. Some people consider a high return on equity to be a good sign of a quality business. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.